economicsfandomcom-20200222-history
Nominal Price Rigidity
Nominal Price Rigidity A.K.A. Menu Costs Nominal Price Rigidity, as opposed to Real Price Rigidity, assumes that the person could be fooled into thinking that the price quoted in current money is the same regardless of the real value of the underlying money. For example, if the price level increases by 10% on some basket of goods, Nominal Price Rigidity would suggest that someone would still expect the price on any certian item to remain the same. This is typically used with respect to wages. If everything I bought suddenly cost 10% less, I would feel wealthier no doubt, however if I feel poorer, in this same state of the world, after recieving a simultaneous 5% pay-cut (as the prices fall 10%), then I am suffering from Nominal Price Rigidity. For the firm or the economy at large this effect would make the movement of prices a less attractive option and there would be an incentive to change less often. Contrast with Classical Real Balance Effect Sticky Prices * “Risk Averse firms”: Firms can sell bonds or they can sell equity. Bonds are a commitment to repay and constrain the performance of the firm. Equity sends a bad signal about the firm. Firms have to meet future obligations with uncertain future demand based and use Portfolio Theory in managing the choices of production in which they engage. * “Credit allocation mechanism in which Credit-rationing, risk adverse banks play a central role”: A way shocks are “amplified” and “propagated.” (Greenwald and Stiglitz 1993 p. 31). (See the Credit rationing link for more) Reserve requirements and restrictions on banks act as a tax on banks. Since loans are a large part of bank net-worth, small changes in underlying conditions of lending have huge effects on willingness to lend. (Greenwald and Stiglitz 1993 p. 33) * “New labor market theories, including Efficiency Wages, Indivisible Labor, Insider-outsider Models, Imperfect Competition, and Implicit Contracts .”: These building blocks should help to explain how price flexibility contributes to macroeconomic fluctuations and to unemployment. In particular, the first two building blocks will explain why small shocks to the economy can rise to large changes in output, while the new labor market theories will explain why those changes in output (with their associated changes in the demand curve for labor) result in unemployment.” (Greenwald and Stiglitz 1993 p. 26) Disscussion of Ackerlof and Yellen, 1985: “First if firms are already choosing their prices optimally, then the cost of not adjusting was of second order. Thus, while the costs of adjusting may be small, so were the benefits of adjusting. Second, in spite of the small (second order) losses to the firm, the losses to society could be first order. …Both propositions apply to ‘’any’’ decision of the firm: they offer no reason to single out pricing decisions.” (Greenwald and Stiglitz 1993 p. 37) “ …Our…theory which emphasizes the riskiness of adjusting prices, rather than the actual adjustment costs. But while our theory does provide a theory of price stickiness, it argues that price stickiness is only one element, and not the most important one, in understanding macroeconomic phenomena.” (Greenwald and Stiglitz 1993 p. 38) Problems It is asserted by Rational Expectations Theory that people will not systematically err in one direction. So it is hard to believe that the economy as a whole would be affected by some notion of Nominal Price Rigidity. Papers have tried to assert that within a firm price is less likely to move when the change is small however, because of this argument. Sources * Greenwald, Bruce and Joseph Stiglitz: “New and Old Keynesians” ‘’The Journal of Economic Perspectives’’ Vol. 7, No. 1. (Winter, 1993), pp. 23-44 * Akerlof, G. A., and J. Yellen, “A Near-Rational Model of the Business Cycle with Wage and Price Inertia,” Quarterly Journal of Economics, 1985, 100, 823-38 Category:Macroeconomics